–  OCTOBER 2017 INSIGHTS BY THE CURVE TEAM –

Highlights

  • The RBA once again elected to leave the cash rate on hold at 1.50% following their October Board meeting.
  • Governor Lowe remained optimistic in the accompanying statement as data largely continues to support the RBA’s central forecasts.
  • Increased rhetoric coming from central banks in regard to the pace of monetary policy normalisation.
  • The consumer continues to be a cause for concern for the RBA following poor retails sales numbers for another month.

Rates Recap

  • The RBA left the cash rate on hold yet again in October with the cash rate remaining at 1.50%.
  • In the post meeting statement Governor Lowe maintained his optimistic outlook on growth and inflation over the medium term.
  • While the RBA remains confident in their outlook, the past month has indicated that time for emergency monetary policy settings globally is drawing to a close.
  • The FOMC has taken a big step forward, leading the charge in announcing that it will begin tapering its $4.5trillion balance sheet whilst markets are expecting the ECB to follow suit and announce plans in the near future.
  • The RBA has indicated that despite a change in global sentiment, ongoing lacklustre wage growth and rising household debt will continue to delay any adjustment to monetary policy settings.

Time for Emergency Monetary Policy Settings Is Drawing To A Close

September proved to be a very interesting month for central banks across the globe. In the wake of the GFC, we have seen an extended period of emergency and accommodative monetary policy settings with ultra-low interest rates and extensive asset purchase programs. Despite ongoing uncertainty around inflation globally, over the course of this month there have been a number of indications that we are entering a period of transition.

Just as they were the first to instigate emergency monetary settings, the FOMC is leading the charge in the process of normalising monetary policy. As largely anticipated, the Fed announced the gradual unwinding of its $4.5 trillion balance in the September meeting while leaving rates on hold. The US has showed strong signs of recovery post-GFC, the most notable being around the labour market whereby the unemployment has fallen from a peak of 10% to now sitting around 4.2%.

The meeting also indicated that Fed members are expecting at least one more hike in 2017 despite inflation continuing to miss the mark. Fed Chair Janet Yellen highlighted this in her speech last week, citing that “it would be imprudent to keep monetary policy on hold until inflation is back to 2 percent.

Following closely behind their North American counterparts on the cycle is the Bank of Canada. Faced with consistent above trend growth, the central bank has been prompted to lift rates twice already this fiscal year. That being said, as the economy continues to progress away from emergency monetary policy settings, there are growing risks particularly around the presence of rising household indebtedness and appreciating CAD that will restrict the BoC’s ability to progress quickly. As such, the rhetoric out of the central bank indicate they will treat each meeting as “live” before any changes can be made.

Across the Atlantic and the sentiment out of the Bank of England is starting to shift. Despite experiencing a lack of wages growth, inflation is nearing a five year high on the back of a falling currency and unemployment is hitting multi-decade lows. The Brexit process and any further fall in the currency could add more pressure on the BoE with Governor Carney stating that “there may need to be some adjustment of interest rates in the coming months.

On the other end of the spectrum is the ECB. Following another reasonable EU GDP figure, the ECB indicated that conditions have materialised enough for the them to potentially start tapering their asset program in the months ahead. That being said, the uplift in growth is still being overshadowed by uncertainty around inflation and hence is still urging patience on the outlook for interest rates. ECB President Mario Draghi highlighted this:

the degree of monetary support that the euro-area economy still needs to complete its transition to a new balanced growth trajectory characterized by sustained conditions of price stability.”

Finally, we have the Bank of Japan whereby it is expected that there will be no change in rhetoric anytime soon. However, the economy is showing some signs of improvement after experiencing slight uplifts in both inflation and growth.

It is evident that the outlook for the global economy is looking increasingly positive and with this comes the change in rhetoric amongst central bankers about the pace of monetary policy normalisation.

Outlook for Interest Rates

Whilst there is a shift in sentiment towards the removal of emergency monetary policy settings, the outlook for interest rates domestically remains largely unchanged. Notwithstanding more optimistic tones coming out of the RBA meeting, conditions are still yet to materialise enough for there to be any change in policy. As such, markets are not pricing a rate hike until August next year.

Business conditions continue to be a point of strength for the Australian economy, unemployment remains low and investment continues to grow. The RBA remains optimistic that as these conditions continue to improve we will see an uplift in wages and inflation. Rates were left on hold for another month, however Governor Lowe was more upbeat, highlighting that:

“Over recent months there have been more consistent signs that non-mining business investment is picking up. A consolidation of this trend would be a welcome development. Business conditions as reported in surveys are at a high level and capacity utilisation has lifted.

That being said, the RBA has been optimistic that business conditions will result in an uplift in wages for some time now. Conditions in the labour market are still yet to materialise enough for wages to lift, despite accommodative monetary policy settings. Lowe was particularly blunt in a speech delivered recently, stating that:

“Over the past four years, the increase in average hourly earnings has been the slowest since at least the mid 1960s.

The lack of wages growth exemplifies the greatest risk to the RBA’s outlook, the consumer. Consumers, the largest contributors to the economy, are coming under increasing pressure from high debt to income levels as well as heightened lending restrictions. The pressures of which are being reflected in the data. Household consumption has been weak of late, only printing 0.7% for Q2 and more recently discretionary spending has taken a hit, with growth in retail sales for the last two months both coming in negative.

With household savings rates also slipping recently, the capacity for consumers to spend above their wage growth will limit the upside risk to the economy overheating anytime soon. As a result, despite many suggesting we could see rate hikes on the near horizon, we are unlikely to see any immediate changes to monetary policy settings domestically.

Australian Economic Highlights

  • Following a weather effected slowdown in Q1, Growth improved in the second quarter with the economy expanding by 0.8%. The Australian economy now holds the record outright for the longest run of growth without a recession at 104 quarters.
  • CPI was weaker than expected in Q2 with the headline reading of 0.2% short of the 0.4% expected. The result saw the annual rate fall below the RBA’s target band. The RBA’s preferred measure, core inflation also remained below the band at 1.8% after a quarterly increase of 0.5%.
  • Employment data continued to reflect strong labour market conditions with total job growth of 54,200 for August, coming in well above expectations. The unemployment rate remained unchanged at 5.6% coinciding with a 0.2% lift in the participation rate.
  • Despite ongoing strength in the labour market, ANZ job ads printed flat for September. This ends six months of robust growth however job ads are still up 12.5% for the year. 
  • The NAB business conditions index continued it’s strong performance in September with the index sitting at 14, remaining well above the long run average of 5. Business confidence lifted from last months decline, posting a gain of 2 points to 7. Interesting was the decline in employment conditions to 7.
  • Consumer confidence continues to languish as weak wages growth and tightening credit standards continue to impact family finances. The ongoing weakness is starting to show up to a greater degree in consumption data.
  • Retail sales continue to be a cause for concern dropping 0.6% in August while the July figure was also revised down to 0.2%.
  • Housing finance continues to be impacted by the macro prudential restrictions imposed by the council of financial regulators. The downward trend in investment housing commitments continued in July, falling 3.9%.
  • A lift in commodities prices month helped lift Australia’s trade surplus for August, the surplus lifted to $989m. The uplift was also assisted by an upward revision to the July surplus, up to $808m from $460m. 
  • Building approvals look like they have reached the bottom of the cycle and trending upwards following the 0.4% increase for August. The lift looks like it is largely attributed to the 4.8% increase in private sector dwellings (excluding houses). Approvals are still down 15.5% for the year.
  • Motor vehicle sales bounced back from the soft July reading, increasing 0.3% for August. 
Oliver Parsons

Oliver Parsons

Client Relationship Manager